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Ruling Clarifies Anti-Money Laundering Due Diligence Obligations of Brokers

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					Client Alert                                                                                    Financial Services Regulation




Financial Services
Regulation


Litigation                   Finance                                                                        June 26, 2008



Ruling Clarifies Anti-Money Laundering
Due Diligence Obligations of Brokers
by Jeffrey R. Zuckerman and Ernest T. Patrikis


                                          1
In an important new ruling , the Department of the Treasury's Financial
Crimes Enforcement Network (FinCEN ) has provided guidance on the anti-
money laundering (“AML”) obligations of U.S. clearing brokers who have
entered into fully disclosed clearing agreements with foreign introducing
brokers.

The ruling makes clear that where the clearing agreement allocates responsibility for opening and approv-
ing customer accounts and receiving and accepting customer orders to the foreign introducing firm, the
U.S. clearing firm does not have a "formal relationship" with the foreign firm’s customers and therefore is
not responsible for conducting due diligence of those customers under either the correspondent account or
the customer identification program ("CIP") rules. 31 C.F.R. § 103.176 (requiring implementation of a due
diligence program for correspondent accounts); 31 C.F.R. § 103.122 (requiring brokers to implement a
customer identification program). However, the U.S. clearing firm does have a "formal relationship" with the
introducing firm and therefore must conduct due diligence on the foreign introducing broker (as opposed to
its customers), including whatever verification is needed for the clearing firm to form a reasonable belief
that it knows the true identity of the introducing firm. The clearing firm must also apply risk-based policies,
procedures and controls that are reasonably designed to detect and report known or suspected money
laundering activity introduced through the correspondent relationship with the foreign firm.



Background
The ruling resulted from Pillsbury’s request for guidance on behalf of a foreign introducing broker whose
customers desired to invest in U.S. traded securities. The proposed clearing agreement between the for-
eign broker and the U.S. clearing firm allocated responsibility to the foreign broker for opening and
approving new accounts and receiving and accepting orders on a fully disclosed basis. Beyond this, the
agreement would have obliged the foreign firm to implement customer identification and verification proce-
dures and to conduct other due diligence "as if it were operating as a broker-dealer in the United States."
Pillsbury sought guidance on this issue.

1
    FinCEN Ruling: Bank Secrecy Act Obligations of a U.S. Clearing Broker-Dealer Establishing a Fully Disclosed Clearing
    Relationship with a Foreign Financial Institution, FIN-2008-R008 (June 3, 2008)



Pillsbury Winthrop Shaw Pittman LLP www.pillsburylaw.com                                              Vol. 1204, No. 2046 | 1
Client Alert                                                                           Financial Services Regulation


FinCEN provided guidance on several related issues: 1) whether a fully disclosed clearing agreement of
the type described is a correspondent account under Section 312 of the USA PATRIOT ACT (also known
as the "correspondent account rule"); 2) whether a clearing firm is required to consider the fully disclosed
accounts of a foreign introducing broker as its own accounts for purposes of complying with CIP rules; and
3) whether FinCEN expects clearing firms to obligate foreign introducing firms to comply with these and
other U.S. AML requirements.



Guidance Provided
With respect to the first two issues, the FinCEN ruling stresses that while there is no formal relationship
between the clearing firm and the introducing firm's customers and therefore, generally, no due diligence
obligations with respect to these customers, there is in fact a formal relationship and therefore a "corre-
spondent account" between the clearing firm and the foreign introducing firm. As result, under the corre-
spondent account rule, the clearing firm is required to "conduct due diligence on the foreign introducing
firm itself." Moreover, since the relationship between the clearing and introducing firms is viewed by
FinCEN as an account under the CIP rules, the clearing firm is required to "verify the identity of the foreign
introducing firm in order to form a reasonable belief that it knows the true identity for the foreign introducing
firm."

The FinCEN ruling explicitly recognizes that the clearing firm need not "look through" the fully disclosed
clearing relationship to perform diligence directly on the customers introduced. Rather, the due diligence
required is to assess the money laundering risk presented by having a fully disclosed clearing arrangement
with the foreign introducing broker. Among the specific risk factors to be considered are the nature of the
introducing firm's business and the markets it serves, the supervisory regime in which the foreign intro-
ducing firm operates, and any information known or reasonably available about the foreign introducing
firm's anti-money laundering record. See note 11 of the FinCEN ruling (citing 31 C.F.R. § 103.176(a)(2)
and summarizing the various factors mentioned).

With regard to issue 3), the ruling states that U.S. clearing firms are not required to obligate foreign intro-
ducing firms to comply with U.S. AML rules for accounts introduced on a fully disclosed basis. Rather, Fin-
CEN expects clearing firms to consider the regulatory regime of the jurisdiction under which the foreign
firm operates in assessing the money laundering risk of doing business with the firm. Moreover, the ruling
emphasizes that clearing firms are required to apply their own risk-based policies, procedures and controls
for each correspondent account. These risk-based measures should be reasonably designed to detect and
report known or suspected money laundering, and should include the monitoring of transactions for intro-
duced customers and consideration of any information acquired about those customers in the ordinary
course of business.



Significance of the Ruling
      Clearing firms naturally want to allocate as much legal responsibility to introducing firms as they can
      in order to limit their regulatory exposure for the underlying customer activity, and, in the absence of
      knowing participation or willful indifference to clearly known facts, this is a proper and sensible
      allocation of responsibility. However, in negotiating a fully disclosed clearing arrangement with a U.S.
      clearing firm, foreign introducing brokers now have a powerful argument—the FinCEN ruling—against
      any effort to shift, by agreement, U.S. AML obligations directly to the foreign introducing firm.




Pillsbury Winthrop Shaw Pittman LLP www.pillsburylaw.com                                    Vol. 1204, No. 2046 | 2
Client Alert                                                                                    Financial Services Regulation


      Whatever AML obligations a foreign introducing firm must bear either under the rules of its home
      jurisdiction or under the terms of a fully disclosed clearing agreement, FinCEN expects that U.S.
      clearing firms will, at a minimum, do the following:

         Satisfy themselves that they know the true identity of the foreign introducing firm and its AML risk
         profile.

         Apply risk-based AML policies, procedures and controls to each correspondent account. As men-
         tioned, these would include monitoring transactions of introduced customers for suspicious activity
         and taking into account information acquired about these customers in the ordinary course of
         business.

      Clearing firms should verify that their policies, procedures and controls are consistent with this latest
      FinCEN ruling. Among other things, exception reports should be checked to confirm that foreign cor-
      respondent activity is captured and organized in a way such that potentially suspicious transactions or
      patterns are flagged for review.

FinCEN’s view of the AML responsibilities of foreign introducing brokers and U.S. clearing brokers operat-
ing under a fully-disclosed clearing arrangement is consistent with its view of AML responsibilities in the
commercial banking context. The ruling should have a positive impact on U.S. markets. By rejecting any
suggestion that foreign introducing brokers must comply with U.S. AML regulations in addition to those of
their home jurisdictions, the ruling should encourage these firms to introduce business to the U.S.



Live Link
FinCEN Ruling: Bank Secrecy Act Obligations of a U.S. Clearing Broker-Dealer Establishing a Fully Dis-
closed Clearing Relationship with a Foreign Financial Institution, FIN-2008-R008 (June 3, 2008) (PDF, 4
pages)


For further information, please contact:

Jeffrey R. Zuckerman (bio)                                         Ernest T. Patrikis (bio)
New York                                                           New York
+1.212.858.1025                                                    +1.212.858.1317
jeffrey.zuckerman@pillsburylaw.com                                 ernest.patrikis@pillsburylaw.com

James G. Wheaton (bio)
New York
+1.212.858.1648
james.wheaton@pillsburylaw.com




This publication is issued periodically to keep Pillsbury Winthrop Shaw Pittman LLP clients and other interested parties
informed of current legal developments that may affect or otherwise be of interest to them. The comments contained herein
do not constitute legal opinion and should not be regarded as a substitute for legal advice.
© 2008 Pillsbury Winthrop Shaw Pittman LLP. All Rights Reserved.

Pillsbury Winthrop Shaw Pittman LLP www.pillsburylaw.com                                             Vol. 1204, No. 2046 | 3

				
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